Fannie Mae and Freddie Mac
Chris Cummings - Director General - 15th July 2008 - 09:57
When Fannie Mae and Freddie Mac were set up by the US Government in 1933 and 1966 to provide liquidity to the American mortgage market, it is doubtful that anyone would have predicted that they would account for over 70% of new mortgage lending. Yet that is the position now being faced by Hank Paulson, US Treasury Secretary, and Ben Bernanke, Fed Chairman. Thought by many investors to be 'too big to fail' that level of confidence is being tested to the limit today. The mortgage giants have been rocked, as their share prices have collapsed. It is a sign of the turmoil in the markets that the American's took the most unusual step of making announcements on Sunday, when markets are closed, rather than waiting until Monday morning.
The regulatory structure in the US is similar to that in the UK, in so far as much, as Prudential Regulation insists that capital must be held to ensure the robustness of an institution relative to its size. Given the profile of these organisations, it was thought that they were even more cautious than the regulator insisted on for financial underpinning. So, Freddie and Fannie were believed to both have considerably more capital than they need. The question is; has that level been set too low? More capital will now have to be injected by the public exchequer - either in the form of preferred shares or subordinated capital. This will protect the organisations but will be bad news for shareholders who will see the value of their stock severely diminished.
That though, is the price of risk. In the mortgage market where risk has been under priced for the last few years, the chickens are coming home to roost. Fannie and Freddie are the biggest chicken coops in the world and so have the biggest problems.
Swift regulatory intervention is promising to bail them, the US economy, and the western world's economy out. This is good news as it is not an American problem. There is no talk of nationalisation here - just of swift action. The failure of Fannie Mae or Freddie Mac would cause severe harm to the US economy and the mortgage markets across the developed world. It would be bad news for the UK mortgage market in particular, given that we still look west for an economic lead. We are still going through a transition phase of realising that the future of capital may lay eastward, far east in fact, in China. The UK economy is realising that we may need to be Janus-like as we look both west and eastward for sources of capital and long term investment. That fact was confirmed again today as RBS stated its long-term commitment to remain a major shareholder in the Bank of China, at a time when its other strategic investments could be heading for the disposal lists.
As a final thought, with Sir James Crosby currently considering what to do to stimulate our mortgage market, he would be well advised to keep a close eye on how the US authorities respond to this problem - our mortgage market is also in severe difficulties. To the outside world it may not be as obvious as it is in the US right now, but to those in the market, the pain is every bit as bad. The UK needs action too and we need it right now!